Windfall Tax Definition

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Windfall Tax Definition

What Is a Windfall Tax?

A windfall tax is a levy applied by governments on certain businesses when economic circumstances enable them to earn above-average profits. Windfall taxes are largely charged on enterprises in the targeted sector that have reaped the most benefits from the economic windfall, which are often commodity-based corporations.

Key Takeaways

  • A windfall tax is a government surtax levied on enterprises or economic sectors that have profited from economic development.
  • The goal is to redistribute surplus revenues in one region for the greater benefit, although this may be a problematic notion.
  • Individual taxes, such as inheritance taxes or taxes on lottery or game show profits, might be seen as windfall taxes.

How Windfall Taxes Work

As with any government-instituted tax measures, there is always a gap between those who support and those who oppose the tax. The advantages of a windfall tax include the money being utilized directly by governments to supplement financing for social services. Those who oppose windfall taxes, on the other hand, argue that they diminish corporations’ efforts to maximize profits. They also think that earnings should be reinvested by businesses to encourage innovation, which will benefit society as a whole.

While windfall gains are taxed in order to encourage taxable firms to drop their prices for the benefit of consumers, the consequence may be to reduce investment since the after-tax return may not be worth the effort.

For example, as of May 2018, the Indian government was contemplating implementing a windfall tax on oil companies in order to lower retail petrol and diesel costs. Oil producers who are paid international rates for the oil they produce from domestic fields would be required to share any money generated by prices above a particular level under the program.

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Windfall taxes will always be a difficult topic fought between prosperous company shareholders and the rest of society. This problem came to a climax in 2005, when oil and gas firms, such as Exxon Mobil, announced record profits of $36 billion for the year owing to increased energy prices.

Windfalls for Individuals

Individuals who receive a big quantity of money as a gift, inheritance, or from game show, gambling, or lottery prizes may also be subject to windfall taxes. Inheritances, gifts from family or friends, and life insurance payments are often tax-free to the beneficiary.

However, the gift or the estate from which the inheritance is received may owe federal, state, or municipal taxes. Any money won from the lottery or gaming is considered taxable income. These wins are completely taxable and must be reported to the IRS through the individual tax return.

A person who receives a large monetary settlement after winning a lawsuit is likely to owe federal tax on the amount earned. While the IRS considers some settlements, such as damages for personal bodily injuries or physical illness, to be non-taxable, the majority of other forms of damages are taxed as ordinary income.

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